Interpreting the Category 3 PRIIP Market Risk Measure Simulation

Summary

The document asks how to interpret a return adjustment formula used to determine the market risk measure class for Category 3 PRIIP products under European regulation. The specific uncertainty concerns the risk-neutral and measured expected-return terms, as well as what to do after aggregating simulated daily returns. It describes a reconstruction of the calculation based on conference slides rather than a complete formal derivation.

The response outlines a simulation workflow: generate paths over the relevant horizon, sum daily returns along each path, then adjust each simulated outcome to a risk-neutral basis. The stated adjustments remove the historical mean, add the risk-free rate, and account for foreign-exchange risk and variance. The explanation is tentative, and the source notes that the legislation is unclear; it does not establish a definitive interpretation or provide a fully reproducible calculation.

Key ideas

• Category 3 PRIIP market risk classification uses simulated returns and risk-neutral adjustments.
• The described workflow aggregates daily returns across each simulated path before adjusting outcomes.
• The adjustment is described as replacing historical drift with a risk-free component and accounting for FX effects.
• The explanation is reconstructed from presentation slides and remains uncertain because the regulation is unclear.

Tags

# Question regarding the Category 3 PRIIP MRM calculation


# Question regarding the Category 3 PRIIP MRM calculation












My question is regarding the European Commission regulation on standardizing the information in the key information documents for PRIIPs. In the Annex IV of the regulation, one can find the explanation on the determination of an MRM class for the category 3 products (paras. 16-24)

Now my question is regarding calculation of the return of the underlying contract, as explained in para. 22, and specifically the formula in 22c:

$Return = E[Return_{risk-neutral}] - E[Return_{measured}] - 0.5\sigma^2N - \rho\sigma\sigma_{ccy}N$

Could anybody give more details on this formula? I personally do not think I fully understand the first two terms in the formula.

I also tried to reproduce the category 3 calculation as given in the Commission presentation, but I miss the point after summing up the simulated daily returns, i.e. step 9.

Thank you!

## Answer by Thegamer23 (score 2)

https://quant.stackexchange.com/a/34215

Actually, it is not very clear the legislation. However, from some slides that EIOPA used in a conference I tried to build back their computation and what I found is that:

1) you simulate 10k with lenght T, so you have a matrix 10k x T

2) you sum over the Ts so you get a vector 10k x 1

3) you have to go in the risk neutral world so from every element from 1 to 10k you remove the historical mean, add the risk free and remove FX risk/variance

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.